A balanced dividend portfolio can provide steady returns for investors, provided they do their research. Buying companies that generate strong and predictable cash flows, and companies that are able to cover their dividends easily, can help weed out the bad income stocks before you buy them.
Dividend stocks should be in stable environments with intact business models. A good example of a bad income stock is Marks & Spencer, who recently cut its dividend due to a freefall in free cash flow. Here are two stocks that I think warrant further research.
‘Never sell Shell’
Royal Dutch Shell (LSE: RDSB) is a stock that has never cut its dividend since 1945 – hence the phrase ‘never sell Shell’. Though it operates in an environment that has recently been in the spotlight with climate change and the Extinction Rebellion, the company has a solid track record of dividend distribution. No CEO wants to be the first one to cut the dividend, and so protecting that legacy is of huge importance.
When the price of crude oil plunged in 2014, the company was trading at a price that had a dividend yield of over 9%. Usually such a dividend is a warning sign that the market doesn’t believe that dividend is sustainable. But in this case, not only did the astute who studied the business pick up a high-yielding stock, they also benefitted from the capital gain in Royal Dutch Shell’s share price.
With oil going nowhere any time soon, I think the stock should be a staple in anyone’s income portfolio.
British American Tobacco
Despite the numbers of smokers steadily decreasing and scaring many shareholders out of British American Tobacco (LSE: BATS), those who held their ground have benefitted from regular dividends. The company has a strong history of growing its earnings in a predictable manner.
Even though the numbers of smokers are decreasing, the population is ever increasing and people are living longer and longer. That means more potential British American Tobacco customers are coming into the planet, and those customers are living longer too. The company is also moving away from cigarettes into vaping, which is expected to be the new frontier of smoking, as well as tobacco-free oral products.
With the company already having an eye to the future, I don’t believe British American Tobacco has peaked.
Income portfolios should be balanced
Income investors should carefully study the cash flow statements, and make sure that not only the cash from operations is sufficient to comfortably cover the dividend, but also make sure that the business generates enough cash to sustainably invest in itself.
Vodafone recently cut its dividend, which is a popular income stock, and this is why we should pick a selection of stocks rather than relying on a single stock for income. Remember – if the dividend is cut, then income investors may sell, placing further pressure on the share price.
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Michael Taylor holds a short position in Marks & Spencer. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019